Cracking down on tax avoidance by multinational companies is good politics. As Ross Gittins notes, voters think ‘those blighters should be paying more tax’. The Coalition and Labor are trying to out-do each other in demonstrating their resolve to make multinationals pay their ‘fair share’.
But if measures to restrict multinationals shifting profits to low-tax jurisdictions are effective and tax is paid where economic activity takes place, this will increase the pressure on Australia to lower its company tax rate to more competitive levels if it wants to maintain and attract foreign investment.
Labor was first off the mark in announcing an international tax avoidance package which included significantly tightening ‘thin capitalisation rules’ to limit multinationals using debt to lower Australian tax bills. The initial response by the Turnbull government was to say that the measure would make Australia less competitive and cost jobs. But the government then announced measures to limit the extent to which multinationals can claim tax deductions for debt (though the proposals were not as restrictive as the opposition’s).
The 2016-17 Budget featured a ‘Tax Integrity Package’, which includes a new Diverted Profits Tax (DPT) — more commonly known as a Google Tax. Australia is following the UK, which is the only other country to unilaterally impose a DPT.
Australia replicated the first limb of the UK’s DPT in 2015, when it enacted the Multinational Anti-Avoidance Law (MAAL), aimed at combatting schemes where a foreign entity artificially avoids having a taxable presence in Australia. The second limb of the UK DPT tackled cross-border transactions by UK residents which result in a ‘tax mismatch’ and lack economic substance. The 2016 Budget measure replicates and extends the second limb of the UK tax.
Will Australia’s Google Tax be effective? Shadow assistant treasurer Andrew Leigh has called it a joke, claiming that ‘putting aside their enforcement measures, the Coalition’s multilateral tax measures are budgeted to raise just $200 million…this falls well short of Labor’s multinational tax package’. However, as Ross Gittins points out, the aim is not to raise tax at the DPT rate of 40% but encourage multinationals to pay tax at the standard 30% rate in the first place – the DPT will only catch the ‘slow learners’.
Has the UK approach worked?
There are mixed reports on the effectiveness of the UK DPT. Most reviews say it is too early to evaluate, although it has been claimed to have influenced Amazon restructuring its operations such that it would pay tax on profits from UK sales. However, the Amazon restructure is Europe-wide and appears to be a response to public pressure in many countries. Forbes ran an article with the headline ‘The Abject Failure of Osborne’s Google Tax on Diverted Profits’. One factor contributing to the sentiment of this piece was a tax settlement between the UK authorities and Google, which resulted in Google paying seemingly not much extra tax given the size of its UK sales (public concern subsequently led to a parliamentary inquiry). Another assessment of the UK DPT (from Clifford Chance) is that it is ‘fundamentally flawed’ and that it’s not clear if it ‘is technically capable of taxing the very arrangements it was created to contain’.
There are mixed views of the effectiveness of the first leg of Australia’s DPT (the MAAL). The MAAL has been cited as influencing Google’s announcement that it will restructure its operations and pay tax on sales in Australia. But the Australian Tax Office (ATO) has issued a tax alert saying it was aware that taxpayers were seeking to use artificial devices and contrived arrangements to avoid being caught by the MAAL.
The second leg of Australia’s DPT as announced in the 2016 Budget will significantly strengthen the ATO’s capacity to tackle multinationals. Its coverage is wider than the UK DPT, and most significantly it is not a self-assessment tax like the UK’s, but involves the ATO deciding when the DPT applies and corporates having to pay the tax before seeking a review. The Australian DPT will potentially cover any related party transaction in a jurisdiction where the tax rate is 80 % or less than Australia’s corporate tax rate. Given Australia’s relatively high company tax rate, this means the DPT will cover transactions in any country with a rate of 24% or less. As a result, the Corporate Tax Association estimates that nearly half of all related party transactions undertaken by large Australian companies would be potentially caught by the tax. PricewaterhouseCoopers has also pointed out that the DPT goes beyond the OECD’s recommendations on Base Erosion and Profit Shifting.
The Coalition may well be right in claiming it has the toughest measures of any comparable country. But if these measures are too onerous and go beyond capturing recalcitrant taxpayers, the laws could deter foreign investment in Australia. It is also not clear how the DPT will relate to Australia’s double tax agreements. The Parliamentary Budget Office warned in 2015 that a unilateral DPT could result in revenge taxes being imposed on the operation of Australian companies in other jurisdictions.
If measures such as the DPT are effective in ensuring that tax is applied where economic activity takes place, the most far-reaching outcome may be that economic activity becomes more sensitive to headline tax rates. A consequence of multinationals being able to lower their effective tax rates through profit shifting is that their investment decisions have not been responsive to headline tax rates. This is a benefit to countries with a relatively high company tax rate, such as Australia. But if the ability of multinationals to shift profits to low–tax jurisdictions is significantly reduced, the incentive will be for companies to shift their economic activity — which means investment and jobs — to low–tax jurisdictions.
The bottom line is that if Australia is effective in combating the ability of multinationals to shift profits, it will have to lower its company tax rate to more competitive levels if it wants to maintain and attract new foreign investment.
Photo courtesy of Flickr user Neon Tommy